Everything you ever wanted to know about Bitcoin

5 February, 2018

Of late, digital currency or cryptocurrency is the buzz word in the financial circuits across the world. This is what the future looked like two decades back where there would be not physical entity to the money but it would exist in virtual world. Cryptocurrency is this ‘money’. It is generated through solving complex mathematical codes using software. Basically, there codes and protocols involved that lends the name ‘cryptography’ to the process and results in the product called ‘cryptocurrency’.

This cryptocurrency has manifested its usage in various forms. Firstly, is a peer-to-peer network which means that the transactions do not pass through an intermediary as is the case with most of our online transactions! There is no controlling authority of the cryptocurrency as it is a decentralized form of currency. The payments made are irreversible to prevent possibility of frauds and both the transaction time and clearance time of payments is in a matter of minutes. Therefore, unlike conventional payment mechanisms where the payment is routed through a financial institution and can be settled as late as many months later (credit cards), this is instant.

As is the case with everything intangible, there is speculation around the validity and the usage of cryptocurrency. Bitcoin is the No.1 digital currency and carries the symbol of BTC or XBT on the ticker. There are other cryptocurrencies like Ethereum, Ripple, Monero, to name a few, but Bitcoin is the oldest and almost synonymous with cryptocurrency. Most of the people think Bitcoin when they think of cryptocurrency.

What is Bitcoin?

The term ‘Bitcoin’ comprises of two parts “Bit” and “Coin”. Bit denotes the relationship with technology, derived from bytes which are a unit of measurement in computer related information technology. Coin carries the meaning of currency. Put together, this term means ‘digital currency’, Bitcoin being the No.1 digital currency.

This name occurred for the first time in a white paper published on 31 October 2008. Subsequently, in that year, a domain name called “bitcoin.org” was registered. Post this, in November 2008, Satoshi Nakamoto published a Bitcoin whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System. Further, he released the Bitcoin software as open source code in 2009 to allow miners to mine Bitcoin. However, the resource was also made limited as the programme enables only 21 million coins to be mined.

The Bitcoin network came into existence in January 2009 when the first block on the chain called the ‘genesis block’ was mined by Satoshi Nakamoto. Thereafter, it became free to be used for transactions for all who would want to buy Bitcoins. Bitcoins can be either mined or purchased through internet providers using regular currency. Mining is a complex process and can be undertaken only by experts. For everyone else, there are providers from where Bitcoins can be purchased and eventually be used for trading, investing or transactional purposes.

Bitcoin providers enable you to secure your Bitcoins in a Bitcoin wallet. Each transaction made from the wallet can be completed only through providing mathematical codes which are asked for at the time of transaction. These codes are provided to the users through their mobile phones. Usage of codes makes every process encrypted and therefore safe. Also, Bitcoin wallet allows you to maintain pseudo anonymity. Your wallet itself is a code (Bitcoin address) and does not carry your name to it. Worldwide transactions can be carried out by you without having to reveal your identity. In fact, Satoshi Nakamoto’s identity is still unknown and he is just a name in the field of cryptocurrency. This feature is met with two conflict thought processes – positive and negative.

Users of Bitcoin welcome this anonymity since further misuse of identity can be avoided which means that chances of fraud automatically reduce. Authorities, in particular, have a dissonance with this concept, as miners can end up earning a large amount of money through this without having to declare the amounts. Conceptually, since this resource is limited, once the 21 million coins are mined, there would be rotation of only these many Bitcoins. The Bitcoin network is also transparent and allows access to the mining status and coins in circulation. So, for investors and traders, it is a win-win option. If the risks are high, so are the returns.

Bitcoins are increasingly getting acceptance and many uses of Bitcoins are emerging. Statistics of 2015 state that number of merchants accepting Bitcoin are more than 100,000 currently. Merchant fees linked to Bitcoin payments are 0% as compared to the 2% charged on credit cards. PayPal, Microsoft, Dell and NeWag were the early companies that started accepting Bitcoins. In 2017, PwC also accepted Bitcoins as a mode of payment from one of their clients in Hong Kong. With big names associated with Bitcoin, its credibility is on an upswing.

The Bitcoin Network

The Bitcoin network primarily functions on blockchain which is a public ledger that takes note of Bitcoin transactions. Transactions that happen have an “interface aspect as well as the “technical aspect”. The former is needed to understand the way a layman can use Bitcoins for transactions while the latter gives complete background information but is more easily understood by programmers.

Interface Aspect: The first step of getting started is installing a Bitcoin wallet. This can be downloaded either on your computer or your phone. Once you do this, a Bitcoin address is generated, however, each Bitcoin address is used only for one transaction and you can generate your Bitcoin addresses as and when you feel the need.

Once you make a transaction, it gets recorded on the shared public ledger called the blockchain. With subsequent transactions from node A to node B, this blockchain keeps adding codes to it. For keeping a record of your transactions, Bitcoin wallets keep a private key or seed with them which are nothing but a secret data piece. This is then provided to the sender of Bitcoins to sign transactions. These are then broadcasted between both the users and the confirmation takes place in a matter of just 10 minutes through a technical process called mining.

Mining in simple words is nothing but inclusion of transaction on the block chain. There are certain cryptographic rules that are the network verifies and then chronologically adds the transaction as a block on the chain. This process is irreversible, so are the transactions that occur through Bitcoins. This is a safety feature added to ensure the blockchains are not tampered with.

Technical aspect: Most of the transaction networks that all industries are used to are centralized networks. Bitcoin network on the other hand is a decentralized peer-to-peer (P2P) network. There is no central point of command or a nodal point. All the computers that participate in the network are equal and are called nodes. At a given point of time, a Bitcoin network may contain 7000-10000 nodes. However, there are some computers in the same network that perform different tasks and are called full nodes. The hierarchy is flat and these nodes run on Bitcoin P2P protocol for full clients (who have downloaded the entire block chain) and on stratum for lightweight clients or mobile wallets (where entire block chain is not downloaded).

Here is a brief description of the three types of nodes:

The full node, as stated above, is a computer that does the routing and contains the entire blockchain database. This can be individual or the one that offers wallet services and can also perform mining. Effectively, these are service providers from where you can buy your Bitcoins from. The routing function of this full node means that the validation of the transaction and its passage to the block happens from here.

Mobile wallets are lightweight nodes that do not contain the entire blockchain database and use Simplified Payment Verification (SPV) as a method to verify transactions.

Apart from these two modes, there are also mining nodes that perform pool mining. Pool mining is an approach to generate blocks through a pool of individual miners. Since the resource of Bitcoins is limited, there is a competition to generate blocks first to get your hands on Bitcoin. Each block when mined generates 50 Bitcoins per block and this number is halved every 210,000 blocks which is approximately a time span of four years. This means that right now the rewards a higher, and that is the reason why individual miners pool together to generate a block and split the reward equally.

Apart from these nodes, there are also servers and nodes that run other protocols like providing alternate wallets and technically specialized mining pools.

How does the Bitcoin Network work?

When a node joins the network, it must discover another node. This is done when the new node sends messages on the network and any other node, irrespective of the location, wishes to join the new node. Once this pairing is done, the new node has to keep seeking for new connections to get embedded in the network and become the part of the network mesh.

Once this is established, you can start with the basic transactions using your wallet. However, if you are interested in mining and want a full node to be run, you have to request for all the transactions that have happened in the network since 2009 from other full nodes. This can only be done by asking them for the information and once it is sent, you need to download the entire blockchain.

For mobile wallets, the downloads are simple and can be done through any of the Bitcoin provider network.

How to buy Bitcoins?

Buying Bitcoin is a simple task. Here is a step-by-step process for buying Bitcoins:

Look for Bitcoin providers: The Bitcoin can be procured by you through a Bitcoin wallet. There are websites like www.blockchain.info or apps like Bitcoin wallet for Android or Blockchain Bitcoin wallet for iOS that can be downloaded. For the same, all you need to provide is an online form.

Sign up: After finalizing your Bitcoin source, you need to sign up for a Bitcoin wallet. This interface will be much like the online banking software that you use for carrying out your transactions. It is easy to understand and easy to use.

Buy Bitcoins: Once you have reached this stage, all that you have to do is use your regular money to buy Bitcoins. There are many methods that are available for the same like using your credit card, debit card or direct account transfer. You can also choose the currency that you want to use for payment of the same.

Once you have purchased your Bitcoins, you can start using them for transactions or trading on the Bitcoin exchange.

Bitcoin exchanges are places where trading of Bitcoins take place. If you are using your Bitcoin at the Bitcoin exchange, then you can trade your Bitcoins for fiat currency. In case of Bitcoin wallets, you can primarily use them for transactions. There are wallets that are specific for trading purposes and they provide you with limited access to wallet capabilities.

Caution: You need to exercise caution while creating your Bitcoin wallets. Instead of providing your name and number, you can use the two-factor authentication mechanism to secure your account. Google Authenticator provides security keys linked to your email address and you can use the same to sign up for a mobile wallet.

What are Bitcoin wallets?

Bitcoin wallet as the name would suggest are software programs where Bitcoins are stored. Unlike the mobile wallets that are linked with your account and have actual currency storage, these are totally digital in nature. To explain in technical terms, Bitcoin wallets are the virtual place where Bitcoins are saved through a private key or a secret number that is generated for every Bitcoin address. Bitcoin address is generated basically with every transaction so that makes the wallet totally encrypted. Essentially, a Bitcoin wallet stores secure private keys that provide access to the user to use his wallet and keep it safe from hackers. There are many forms of a Bitcoin wallet namely:

Desktop wallet: These are the wallets that are installed on desktop computers. These desktop wallets are comprehensive and provide complete control to the user over the wallet and the transactions that happen through it. The private key can be stored by the user. Some of the commonly used desktop wallets are Bitcoin Core, Hive OS X, Electrum, Armory etc.

Mobile wallet: Mobile wallets, as the name suggests are smaller sized equivalents of your desktop wallet. The functions are the same; however, it is a simplified version. This gives you the flexibility of carrying our wallet on-the-go and transact at anytime from anywhere. Bitcoin wallet, Mycelium Bitcoin wallet and a version of Hive Android are some the commonly used mobile wallets.

Web wallet: Web wallet is a kind of wallet that cannot be downloaded and is present on the worldwide web. For security, many private keys are provided and the transactions are always through encrypted codes. This is a popular kind of wallet amongst cryptocurrency wallets. Some of the most commonly used web wallets are Coinbase and Blockchain.

Hardware wallet: Hardware wallet is a new kind of wallet where your wallet is available in a hardware device. The hardware device will be enabled to provide you with private keys to be used to carry out transactions. However, this is at a very nascent stage at the moment. Once the acceptance of Bitcoin transactions will increase, hardware wallets will prove to the most convenient.

The key to maintain your cryptocurrency wallet is to keep it safe. For the same, you must always go in with a service provider that offers encrypted wallets. Hackers have successfully attacked many Bitcoin wallets in the past and hence, the Bitcoin service providers are working on building in more safety features in their wallets. This parameter must always be checked before going in for your Bitcoin purchase.

Use of Bitcoins

Bitcoins are slowly and gradually gaining acceptance and their usage is increasing for transactions worldwide. The biggest advantages associated with Bitcoins are speed of transactions, instantaneous nature and lowest cost of transactions. Some of the uses of Bitcoins are as under:

Trading: Trading has been one of the major reasons why people have moved towards cryptocurrency. Just as is the case with currency exchange, a Bitcoin exchange is a digital marketplace where you can buy and sell Bitcoins. The transactions take place through fiat currencies or altcoins. There are online Bitcoin providers that provide you with an access to this currency and also guide you through the trading process, much like the regular currency.

The volatile nature of Bitcoins and the ‘high risk, high reward’ caveat that it comes with makes Bitcoin trading very interesting. In a Bitcoin exchange, seller determines the price at which he would be willing to sell his Bitcoins for. The trader will get access to the seller who is asking for the ‘best price’ from the perspective of the buyer (which would always be the lowest price). Depending on the quantity demand then, the order is fulfilled through the respective seller or if his quantity of Bitcoins is not sufficient to meet the buyer’s requirements, it moves on to the seller who is next in line with the best price offering.

Traders can also set the best price for the day and sellers can directly contact these buyers/traders. There is a small transaction fees that needs to be paid for carrying out trading within the exchange. This varies from one exchange to the other and with increasing popularity; both the exchanges and the ticker symbols for Bitcoin are evolving. For safety purposes, there are authenticity checks built in for users to first register on the exchange and go through certain verification stages. Once this is established, trading is permitted and it can be done using various payment methods like credit cards, debit cards, bank transfers or even bank wires. Bitcoin is denoted by the tickers XBT or BTC, depending on the exchange. There are other nuances of trading also like currency exchange which can be understood along the process.

Online Retailers: There are many online retailers who have opened up the prospect of using Bitcoins. Amazon, the world’s largest marketplace allows transactions through this medium. Other retailers like Nike and Wal-Mart have also embraced the concept of digital currency. They allow transactions to be done on their merchant retailing sites through Bitcoins. The support of big names is lending credibility to the concept and it will not be long before other online retailers follow suit.

Investment Tool: Bitcoins have proved to be a great investment for those who invested in this concept five years back. The cost of Bitcoin was USD 1 in the year 2009 when it just came into being and since 2013; the growth rate of Bitcoin has been phenomenal. By end of 2016, Bitcoin had reached the mark of USD 968.42 as per the Coindesk Bitcoin Price Index. It grew at a rate of 700% alone in 2016 and as per the predictions; the rate of returns will remain very competitive till 2020. It is then the coins mined per blockchain would be reduced to half as is the design that is meant to do this self correction every 4 years. Since, this is a limited resource with only 21 million Bitcoins to be mined; passage of time will only make it an even more sought after possession.

Travel and Tourism Operators: Airlines and hotels have started accepting Bitcoins as their mode of payment. Preferred travel websites like Expedia have opened their doors for Bitcoin. Hotels like Holiday Inn and One Shot hotels have started transacting in Bitcoins. More so, even some real estate agents are allowing purchase of property through Bitcoins. This trend is sure to gain strength with time as this industry is a major money cruncher. Transactions in this industry run in high values and therefore the charges levied when transactions come through an intermediary also become substantially high. The method of payments through Bitcoins is decentralized and completely devoid of any other level except the sender and the receiver. This is going to be the biggest advantage that Bitcoins will have over other forms of payment in times to come.

Trucking Industry: Trucking industry has really taken to Bitcoins in a big way. The job of truckers require them to be on the road for extended durations and carrying cash for all the duration is neither practical nor advisable. Therefore, they have started using Bitcoins as their mode of payment. ATMs are also not in the vicinity on some highways and with internet connectivity, payment through Bitcoins is just a matter of few clicks. Also, Bitcoins transcend barriers, so currency and country does not matter in these transactions.

Purchase of commodities: Commodities of daily use can be purchased through Bitcoins. Dell accepts this as currency for all of their products. Coffee, pizza, hotel rooms and airline tickets are other products and services that allow usage of Bitcoins. This is a sign towards the acceptance of Bitcoins and is surely going to be an added method in the future for all kinds of payments.

Other uses: Other uses include using Bitcoins in marts that accept this format. So, basically you can buy anything available at these format stores using Bitcoins. Wal-Mart, TigerDirect, NewEgg and OverStock are a few names that come under this category.

There are many Bitcoin directories available that can provide you with buying options. Airbitz and Coinmap allow you to find Bitcoin friendly merchants available online and near your location. Open Bazaar is a decentralized marketplace that allows the usage of Bitcoins. Purse.io acts as an intermediary and gets you discounts on Amazon on the usage of Bitcoins. All these are proof enough that slowly yet steadily Bitcoins are firming their grip on the ground.

Why buy Bitcoin?

Fluctuations in the global financial markets and short term nature of currencies of the world have shifted the focus to digital currencies. Amongst the digital currency or cryptocurrencies available, Bitcoin has been around for the maximum number of years. There are many reasons why you should go in for Bitcoins at this point of time.

Firstly, Bitcoins are a great investment tool for the future. Scarcity of resource always makes the value of the product go high in the future for e.g. Gold. There are only 21 million Bitcoins that can be mined and miners are working day in and day out to get these coins at hand. Pool mining is also being done so as to increase the efficiency of the process. People who invested in Bitcoins in the early years of its inception have reaped in returns to the tune of 700%.

The second advantage of buying and owning Bitcoins is that these are extremely easy to use and offers amazing portability. The usage of Bitcoins is like using any other method of payment with the only difference being that there is no payment gateway here that charges transaction fees but the transaction is direct. Anonymity of the sender can also be maintained and there is a private key that enables transactions through the mobile wallet. Portability as an advantage is so huge that this will be the game changer in times to come. This digital currency can be used all across the world through the medium of World Wide Web. Their current reach spans over 140 countries across 20 currency conversion rates.

Thirdly, the risk of inflation involved in cryptocurrencies is really low. There is no Government or any other banking institutions involved in the creation or rotation of Bitcoins. That means that it is completely safe from inflation. Privacy of the account and the safety features built in with Bitcoin wallets make it a completely safe tool. Encrypted passwords add protection from hackers and the risk of losing your money owing to malpractices is really low with Bitcoins.

How are Bitcoins mined?

Bitcoin mining is an interesting mechanism. Unlike regular currency which is in hands of the Government, this can be mined by anyone. Bitcoin miners are usually experts who use softwares to solve complex mathematical problems. They are rewarded Bitcoins at the end of successfully solving these.

Bitcoin mining is a method in which transaction records are added to the block which is a kind of a public ledger that contains all the past transactions, collectively called blockchain. The nodes on the Bitcoin network verify if the transactions are valid. Upon this validation, all the transactions are bundled in a block. Then the most recent block’s header is inserted into the new block as a hash. This serves as the new problem for the miners to solve. The solution of the problem is basically providing proof of work. Once the solution is found, the new block is added to the local blockchain and then integrated into the network. The miners get rewarded by way of Bitcoins and they can start transacting these to create the next mining block.

Proof of work on the block is also a thought through phenomenon. This is examined to check if sufficient work was carried out in the new block to ensure the mining of Bitcoins. It takes into account the hardware that was used, the power or energy consumed in the process and the time taken for the mining to happen. It is not an easy process and the hash may run up to a 256 bit number when finally the miners get rewarded with the Bitcoins.

Another caveat with the Bitcoins is that the block reward or the amount of new Bitcoins released through mining of each block is halved after every 210,000 blocks which is roughly a period of 4-5 years. In 2009, the Block reward was at 50 Bitcoins which became 24 in 2014 and will further reduce to 12.5 by 2020.

The mining efficiency of the miners is increasing and pool mining has enabled miners to reduce the time of mining to 2 weeks in 2016. During the inception of Bitcoins, CPUs from normal computers were used. It later moved on to GPUs but eventually ASIC (Application Specific Integrated Circuit) came into being and has been in use since 2013 up till now.

To increase the efficiency of mining Bitcoins, cloud mining is becoming increasingly popular. The mining is done on cloud and factors like hardware, software, electricity and other issues do not come into consideration. This is done without Bitcoin mining equipment and is convenient. The disadvantage of this process is that it may not yield in Bitcoins and profits are lower. There is also lower credibility to the process and some also deem it as fraud.

Pool mining on the other hand is a preferred way to mine Bitcoins. Many nodes on the blockchain come together to give in collective hours for the process of mining. Once the problem is solved, miners share the booty. As 2020 is approaching, this process is becoming increasingly popular because the reward is going to be halved soon. Until then, proportionate effort will yield proportionate results. Post 2020, output will become disproportionate to the input and this is when the value of Bitcoins may exponentially rise.

Why the skepticism?

Bitcoins, like any other financial instrument has been at the receiving end of criticism. There are reasons why investors are wary of investing in this trend, and it is good to know the reasons when put in proper perspective. Here are some of the reasons for skepticism around Bitcoins:

Lack of Centralized authority: There is no centralized authority when it comes to cryptocurrencies. Lack of a regulating authority means there is also lack of regulation in the transactions using Bitcoins. The Governments of many countries have distanced themselves from Bitcoins and have advised investment at the own risk of investors.

Confusion over existence: Lot of people tend to compare cryptocurrencies with Gold, silver etc and hence have attached the term mining to it. In reality, these are intangible and therefore cannot be classified into a commodity like gold and are being termed as currency. Currencies have so far been regulated always and no authority over this commodity/currency labels it a high risk resource.

Volatility: The market for cryptocurrencies has been extremely volatile. The growth of the currency is only dependant on a demand-supply formula which the experts deem very futile as a long term plan. Even volatile instruments of investment like stocks are dependent on the company’s growth, its earning, turnover and other parameters. This means that there is an informed risk. Here, the risk is not informed and the trends are not suggestive of the future. For e.g. Bitcoins grew by 750% in the year 2017 but fell down by 30% once China raised the issue of its legality. Such volatile instruments are mostly avoided by regular investors and may find acceptance only amongst those who have surplus money to invest.

Fake schemes around Bitcoins: The concept is relatively new and the lack of centralized authority means that there is also a lack of understanding that exists between people about this product. Fraudsters are taking advantage of this and there are many websites that have cropped up that claim to trade Bitcoins for you for a said amount of investment. Since there are no consultants in this field, the risk of investment becomes really high for novices.

Fear of drastic decisions: Countries of the world are thinking of banning this currency. China has already taken first steps towards this. Government of other countries like India have also distanced themselves from it, although has not banned it as yet. If the ban on the currency happens, then the future is uncertain.

The Future of Bitcoins

Bitcoins are definitely touted as the currency of the future. These coins have a reach in over 140 countries with over 20 currency conversion rates as of now and this is only going to increase as years pass by. 2017 was a good year for the cryptocurrency and 2018 is going to be even bigger, say financial experts.

2018 will mark the ten year mark for the existence of Bitcoins and analysts say that the price could go 10 times higher in this year. Bitcoins have so far been most popular amongst cryptocoins but other coins like Ethereum and Ripple will also gain traction.

Bitcoins have not been advertised aggressively so far but the peer publicity of Bitcoins has become popular. Those who have benefitted with the use of Bitcoins are spreading the word and many new investors are joining in the network. There are investors who are not willing to spend a huge amount on Bitcoins and are reaping in the interests with trading only 1 or 2 Bitcoins. This trend will see acceptance in the years to come and Bitcoins will grow in width also as well as the depth (value) that is associated with it.

Merchants, traders and online retailers have started accepting Bitcoins. This trend will also remain on an upswing and the future looks bright and inviting as of now. Government acceptance of Bitcoins is the only area that is still speculative and only time will give the verdict here.

Conclusion

Bitcoins are an interesting and intriguing concept. It is transparent and open to all, yet needs specialists in the field. The fact that it is logical and thought through lends credibility to the concept. Many investors have benefitted largely though the use of Bitcoins and will continue to do so in the coming years.

If you are an investor looking at quick gains, then this is the currency for you. Add to it, the ease of transaction and the merchant vendors that are opening up to this concept and you will be sure that your money will not be lost anywhere.

Start slowly, spend a small amount, get gains and gain experience as you enter this fascinating world of Bitcoins.